After last week’s Federal Reserve announcement, investors are mentally adjusting to an extended ZIRP mentality — three more years of Zero Interest Rate Policy (’til the end of 2014). The jobless rate is near a three year low, but that’s still too high for the powers that be.
So what are some of the consequences of living in a zero percent world? And what does it mean that it could last another three years?
- More punishment for savers (especially the elderly). The pain will continue for those on fixed incomes, with nonexistent rates of return for traditional safe savings instruments. If your grandmother isn’t willing to move out on the risk curve, she’ll probably lose ground to headline inflation (the total inflation number including food and energy, which the Federal Reserve ignores).
- Increasing social inequity (and rising social unrest). The U.S. economy has been laid low by the excesses of the leverage and debt supercycle. The aim of current policy is to heal the economy on the whole, but the medicine of cheap credit is only good for those who can tap it. This feeds a widening gap between the “haves” and “have nots” on Wall Street and Main Street.
- A growing obsession with dividends. With interest rates near zero, there is a broad investor consensus that conservative, high quality dividend stocks are the place to be. A 5% return looks great in comparison to the doldrums of a money market account. But a herd mentality risks disappointment for those who chase too aggressively, or forget that no dividend is true protection against sharp downside decline.
- Compressed money manager returns. Investment returns in general are likely to stay compressed, especially in comparison to the “good old days” of expanding leverage and economic growth. When short-term savings rates are meaningful (say 5% or more) and economies are booming, it’s far easier to deliver double-digit absolute returns. But the more we hug zero, the harder it is to tack on each percentage point of gain.
- High speculative premiums for growth. With fewer areas of the market looking exciting, the handful of industries and companies with true growth prospects will continue to get more attention. It’s the principle of limited supply relative to pent-up speculative demand at the margins. This means an exaggerated cycle of booms (and busts) for the Netflixes, Amazons, Facebooks and so on.
- A schizophrenic forex market. The U.S. dollar is the Rodney Dangerfield of currencies — it gets no respect. And yet, the euro is a basket case, the yen is a demographic timebomb, the pound is recession prone, and the commodity currencies (Aussie, Canadian etc) are tied to a China growth bubble. The $USD has two ways to win: 1) As a result of U.S. led recovery, or 2) as a result of “risk off” capital flight (out of overseas assets, back into treasuries etc). But the Fed’s willingness to play whack-a-mole every time the dollar index lifts its head will keep the picture muddled.
- A favorable hard asset profile. Gold is dismissed by traditional value investors because there is no effective way to value it (and no cash flow or dividends to accumulate). But gold is a useful form of insurance against central banker screwups… and in a zero rate world the lack of dividend is no handicap. Other hard assets that function as “stores of value,” in comparison to debased paper currencies, could also see new upside along with signs of global recovery.
- Continued trading emphasis on income and mean reversion plays. In 2011 the majority of big trends were killed in the cradle. At extended levels both higher and lower the markets showed a clear tendency to reverse, retrace, and then reverse again. This choppy, trendless action favored mean reversion strategies — fading at extremes — over trending one (buying breakouts etc).
There are bound to be some curveballs in 2012 (and some big surprises too).
Our game plan is to continue hunting for major trend possibilities, but to augment that process of “big game hunting” with an overlay of income generating mean reversion type strategies in this confused, government manipulated environment.